Toy Story

Toy Story

Toy Story

Dec. 26 1997 3:30 AM

Toy Story

Toy Story

Not that long ago, in a galaxy very, very close to home, the nation's third-largest toy company tied its fortunes to the most popular film series in history. In a strange way, it's been paying for that decision ever since.

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The toy company is not Mattel or Hasbro, but Galoob, makers of Sky Dancers, My Pretty Dollhouse, Men in Black action figures, and Micro Machines. The film series, of course, is the Star Wars trilogy. For five years, Galoob has been making vehicles and action figures based on those films, and that arrangement by itself catapulted the company into the ranks of major toy makers. This year alone, Galoob will sell $120 million worth of Star Wars toys. And while sales this year were obviously boosted by the re-release of the trilogy, George Lucas' creation has become a source of perpetual revenue in the 1990s. Since the first film came out, Star Wars merchandise sales have totaled more than $2.5 billion.

It's safe to say, in fact, that Star Wars single-handedly created the film-merchandising business. While it had always been possible to buy movie posters or souvenir plates (and God knows we're thankful for the plates), the concept of creating a toy universe replicating the one in the film somehow eluded movie makers until Lucas came along. This isn't because Star Wars was the first movie that lent itself to action figures and plastic vehicles. One could easily imagine James Bond toys--as there are now--or toys based on The Man From U.N.C.L.E. It's a classic example of a company creating a market rather than responding to an existing one. No one knew how much kids wanted action figures until they were offered them.

The result, of course, has been a flood of toys based on everything from comic books to Westerns. (Galoob is even in the process of hurriedly rushing to market 11 ½-inch Spice Girls dolls, hoping to cash in on the frenzy before the British quintet end up in Palookaville.) Nothing drives home the ephemeral nature of popularity better, in fact, then wandering through the action-figure section of Toys "R" Us and seeing the deep discounts on toys from films that were supposed to be hits but weren't. Ah, there's a Schwarzenegger figure from The Last Action Hero! There's the Riddler from Batman Forever and Poison Ivy from Batman & Robin! And they're all yours for 80 percent off.

The problem for toy companies is that they need to design and manufacture the toys for a movie without having any sense of how popular that movie is going to be. You can easily end up making $50 million worth of Hercules toys only to watch the orders dry up as the movie tanks. On the other hand, if the movie's popular and you don't have enough product on hand to take advantage of those few weeks when your toys are hot, you won't get the chance again.

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The one exception to this short-life-expectancy rule is the film series that started the whole exhausting merry-go-round. Star Wars toys did go through a long slump, but since 1992 or so they have been consistent winners. As the incredible box-office numbers for the trilogy's re-release showed, there are millions upon millions of American children, born a decade or more after Luke Skywalker first appeared, who nonetheless see him as their hero. This is a phenomenon that could only have happened in the age of the videocassette recorder, but even so it remains an anomaly in the world of pop culture. Where almost everything else gets consumed and cast aside almost immediately, Star Wars has been able to remain somehow fashionable.

Galoob, as it happens, is not the leading manufacturer of Star Wars toys. That honor belongs to Hasbro, which swallowed Kenner in 1991. Kenner had been given the license to make Star Wars toys "in perpetuity" back in 1977, and was responsible for those little plastic Darth Vader and C-3PO figures that now sell for hundreds of dollars at collectors shows. But soon after Hasbro acquired the company, it made one of the great blunders in the history of merchandising, forgoing its licensing fee to Lucasfilm because the sales of Star Wars toys were in a bad slump. Lucasfilm turned to Galoob, which created an entire new line--the Micro Machines--of Star Wars toys. When those toys took off, Hasbro jumped back into the fray, but Galoob was there to stay. Some have even suggested that Galoob, by proving that the franchise still had legs, was indirectly responsible for this year's revival and for the prequel trilogy that will debut in May of 1999.

This, then, is a story to warm the heart of any entrepreneur. Small company sees big opportunity, seizes it, and reaps the rewards forever after. The only problem is that Galoob doesn't own the franchise. Lucasfilm does. As a result of the Star Wars deal, Galoob devoted more and more of its resources to that line, shifting money out of internal development, staking the company, in a sense, on this product whose existence depended utterly on staying in the good graces of Lucasfilm. This year, Galoob found out exactly what dependence means.

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T he Star Wars toy contracts were scheduled to expire next year, which sparked a bidding war this fall. Mattel offered $1 billion for a decadelong contract, while Hasbro sought to expand its current $200-million-a-year business. Galoob, having less cash than either of the two big toy makers, offered part of itself. In the end, Galoob was able to secure a license and guarantee its future, but in exchange it mortgaged the farm. Beginning in 1999, Lucasfilm will receive $140 million a year in advance-royalty payments, plus a set percentage of all toy sales. More strikingly, Galoob gave Lucas options to buy 20 percent of the company at $15 a share, which at the time the deal was made was a bargain. Galoob's future is solid--once the first film of the new trilogy comes out, sales of its toys could reach as much as $400 million a year. But more than ever, that future will be tied very tightly to the desires of Lucasfilm.

As it happens, right now the deal isn't looking as great for Lucasfilm as it originally did. Announcement of the terms sent Galoob's stock plummeting, so that Lucasfilm's options are now out of the money. (It would be cheaper to buy the stock on the open market than by using the options.) Still, the stock price will likely improve as 1999 nears. And Lucasfilm does hold all the cards.

There's been a lot of overdone talk in the last couple of years about the transformation of the U.S. economy away from one based on manufacturing toward one based on ideas. But the more interesting transformation signaled by the relationship between Galoob and Lucasfilm may be the one from an economy in which companies design and make products in-house toward an economy in which those functions are separated and contracted out. And in this new world it's not the company that owns the assembly line that has real power. Instead, it's the company that owns the name that dictates the terms. Anyone can make toys, apparently. But not anyone can stamp the Star Wars tag on them.